Yes, Microfinance has Positive Effects on the Poor

Microfinance in its simplest form involves extending loans to a group of borrowers (usually called self help groups) who agree to help each other by means of group savings and informal support. The typical self help group consists of 10 to 20 people who meet regularly to discuss social issues and activities and deposit their savings in a joint bank account. Once enough savings have been accumulated, group members can apply to internal loans within the group or apply for loans through a commercial bank.

Even though microfinance is estimated to have directly reached 100 million customers in 2008 (for more details see my previous post) there is still plenty of debate about whether it has a significant impact on the lives of the poor or not. There are many good reasons why it may benefit or harm the people it tries to help. In theory, microfinance self help groups are better at allocating resources because it takes advantage of more comprehensive local information regarding local needs and lower monitoring costs, thus mitigating challenges like moral hazard and adverse selection. Therefore transferring resources to self help groups should result in local empowerment and efficiency. On the other hand, those resources devoted to the self help group may be appropriated by local elites. Additionally, if these resources are channeled through institutions parallel to local governments they may undermine rather than strengthen local capacity.

The problem with testing which side of the story is true is that researchers need very high quality data along a period of time. Most of the studies so far have depended on either incomplete or anecdotal information. As a result the debate has gone on for several years now and opponents of the microfinance approach could at least claim that no study has conclusively proved its positive effects on the poor. That was until now.

World Bank researchers, Klaus Deininger and Yanyan Lu have recently published 3 articles in which they take advantage of very detailed household data to find out what exactly are the effects of microfinance self help groups on the poor (see article 1, article 2 and article 3). Using a randomized experiment methodology (which I have advocated for BoP research in a previous post as well) they use survey data for years 2004 and 2006 comprising around 2,400 households and more than 3,000 loans in the Indian state of Andhra Pradesh.

The authors find that there are significant economic gains from program participation in the form of better nutrition, increased asset accumulation, higher levels of consumption and consumption smoothing. Apart from the economic impact, self help groups also have important social effects as reflected in the authors’ measures of female empowerment. Moreover, the authors find that for most of these cases, benefits often accrue to non-participants as well and thus microfinance self-help groups have important positive spillover effects.

Surprisingly, no significant effects where found with regards to the incomes of the poor. This may mean that either microfinance does not have any impact on income or, as the authors believe, that the hypothesized positive impact has not been able to materialize in such a short period of time due to the severe drought occurring in the area at that time which resulted in crop failures.

In spite of the authors’ best efforts these studies are still subject to criticism. The most important weakness is the fact that data is available only for two periods. This weakness is palliated by using a randomized experiment methodology. Nonetheless, the effect of self-help groups is not fully rooted after one period and so one may argue that negative effects have yet to kick in or that the study capitalizes on chance. Moreover, since the survey data is quite localized it may be the case that such positive findings are dependent on some specific local factor in Andhra Pradesh or in the microfinance program in which the survey was conducted.

Although all these criticisms are valid, considering how widespread and standardized microfinance endeavors currently are, it is hard to believe that one particular detail which can not be extrapolated to other microfinance programs may be driving the results. Basically and in my opinion, thanks to these studies the debate about the impact of microfinance on the poor is laid to rest.

So, if you find yourself engaged in a debate about the usefulness of microfinance, from now onwards let the speaker know that yes microfinance has been proven to have a significantly positive economic (consumption, nutrition and asset accumulation) and social (female empowerment) impact on the of the poor and that this positive effect is very likely to be felt by at least 100 million people. (And if they still have doubts direct them to this post!).